Aftermath: The Street Guesses About Yahoo-Google, Yahoo-MSFT (Again), and Who Buys AOL

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Includes: AABA, GOOG, MSFT, TWX
by: Eric Savitz

The Street this morning is sorting out the implications of Microsoft’s (NASDAQ:MSFT) decision to drop its offer for Yahoo (YHOO). The short version, as I noted earlier, is that this is excellent news for Google (NASDAQ:GOOG), boosts the prospects for Time Warner (NYSE:TWX) selling AOL, crushes Yahoo shares and gives a modest lift to Microsoft.

Yahoo CEO Jerry Yang is expected to spend some time with lawyers as the company likely will face shareholder litigation over the its opposition to doing a deal. Yang’s also likely to have some face time with Google CEO Eric Schmidt: There will be pressure on the company to do an outsourcing deal for search advertising to Google, although not everyone thinks this is a good long term plan, and it may not pass regulatory muster.

There’s also speculation that MSFT will eventually come back and try again; the view there is that MSFT’s decision to walk away is basically a tactic to drive down YHOO shares and push the company back to the bargaining table.

Here are some excerpts from this morning’s batch of research on Yahoo, Microsoft and Google.

On Yahoo:

  • Clayton Moran, Stanford Group: “Yahoo missed an opportunity…Yahoo’s best alternative was to sell to Microsoft. As an independent company, Yahoo has lost market share and struggled to grow cash flow. We suspect these trends will remain intact for the foreseeable future.” He has a Hold rating and $24 price target on the stock.
  • Mark Mahaney, Citigroup: He cut his rating to Sell from Hold, and his price target to $26 from $34. He sees 3 scenarios from here. One is “back to business as usual,” in which the stock gets a “media multiple,” and is worth $22 a share. Two is that the company does a major strategic partnership with Google, or AOL or MySpace, maybe a big buyback or the sale of its Asian assets. The biggest opportunity is outsourcing search to GOOG, which he says can boost cash flow by $1 billion a year or more. The third alternative? A deal actually happens, maybe at $35.
  • Jeetil Patel, Deutsche Bank: Hold rating, $17 target. “We expect Yahoo to trade back to pre-bid levels, or into the upper teens. It is now back to business at Yahoo, yet the online advertising market has slowed, the easy [revenue per search] gains have already played out, key execs have departed and U.S. traffic growth still looks to be on the decline.”
  • Jim Friedland, Cowen: He repeated his Neutral rating, and says the company has significant challenges, including loss of market share in search, declining user engagement in non-search areas and high exposure to an economic downturn for the display ad business.
  • William Morrison, ThinkPanmure: “Likely to go down as one of the more destructive decisions for shareholder value in the history of Internet stocks…to say we are disappointed is an understatement - dispirited is more like it…the biggest losers, in our view, are YHOO shareholders, who may not see YHOO shares reach Microsoft’s bid price via the company’s organic turnaround efforts anytime within the next two to three years…the best-case scenario for shareholders may be for a declining share price and worsening fundamentals in coming quarters to force Yahoo management back to the bargaining table. However, we would expect Microsoft to be significantly less generous in such a scenario.” Rating cut to Sell, from Accumulate; price target to $20, from $31.
  • Gene Munster, Piper Jaffray: Cut price target to $23, from $31; maintains Neutral rating. He says there is still about a 30% chance the companies come back to the table.
  • James Mitchell, Goldman Sachs: He has a Neutral rating and $26 price target. He notes that there are precedents for thwarted bidders trying again - Oracle and BEA is the most obvious example. Mitchell also notes that outsourcing search to Google could boost revenue by $850 million in 2009, but cautions that many search affiliates would ultimately simply defect to Google, reducing the impact to revenue.
  • Mark May, Needham: Maintains a Hold rating. He says management will now need to respond “with a transformational partnership or transaction,” such as the contemplated deal with Google. But he says it remains unclear if that would be enough to enable YHOO to hit its aggressive ‘09 and ‘10 financial projections.
  • George Askew, Stifel Nicolaus: Askew raises the possibility that Yahoo could face not just shareholder suits, but also the nomination of dissident director slates. He maintains a Hold rating on the stock.
  • Benjamin Schacter, UBS: He sees several alternatives for Yahoo. Outsourcing to Google, he says, could add $850 million to $1.6 billion in annual revenue, but he sees such a deal as a long-term negative, asserting that it would “virtually destroy Yahoo’s search affiliate business, as partners would have an economic incentive to leave Yahoo’s network and join Google’s directly.” Other options include unlocking the value of its Asian assets - he sees a tracking stock as one potential approach. And he thinks deeper cost cutting of non-core businesses is also likely to be considered.

On MSFT:

  • Sarah Friar, Goldman Sachs: She reinstated a Buy rating and $38 price target. “We view Microsoft as a defensive investment in the current environment and the decision to walk from the Yahoo deal suggests at least some price discipline.”
  • Walter Pritchard, Cowen: “Is withdrawing the bid just a negotiating tactic? We don’t believe so. MSFT is far enough behind in this area that it needs to commit to a strategy and waiting on a Yahoo acquisition simply puts the company further behind.” He repeats his Outperform rating.
  • Charles DiBona, Bernstein Research: “MSFT’s walking away not only signifies substantial financial discipline but also highlights the extent to which speed was a primary driver of their pursuit and the extent to which the drawn-out process of a hostile tender would have undermined that driver,” he writes. DiBona maintains an Outperform rating and $41 price target.
  • Brent Thill, Citigroup: He repeats his Buy rating and $41 target. He notes that MSFT will breathe a sign of relief, since integration would have been a “considerable distraction,” the price discipline “sets a strong precedent for future M&A” and the deal would have been dilutive near-term. Thill says the company can now spend sits billions on other deals and buybacks.
  • David Hilal, FBR: “Despite the withdrawal of the offer, we are not convinced that MSFT is going away for good,” he writes. “In our view, taking away the bid is likely a public negotiating tactic from MSFT that is designed to incite YHOO shareholders to pressure its board to ratchet their expectations down…MSFT is essentially telling YHOO shareholders that they could have gotten $33 per share if not for the unrealistic demands of their board. Should the frustration of YHOO shareholders come to a boil, we believe MSFT could renter the picture, essentially playing the role of the white knight.” He maintains an Outperform rating and $40 target on MSFT.

On Google:

  • George Askew, Stifel Nicolaus: He upped his target on GOOG this morning to $675 from $610, asserting that GOOG is the best positioned company to benefit from the collapse of the Microsoft/Yahoo negotiations. The risk of a stronger rival has been eliminated, and “Google stands to benefit modestly if and when Yahoo outsources a portion of its sponsored search advertising to others.”
  • James Mitchell, Goldman Sachs: Mitchell upped his target on GOOG to $650 from $560; he says that “Google may benefit from the disarray of its two largest competitors.” Mitchell says an outsourcing deal with Yahoo could boost GOOG’s revenues by about $300 million a year, and lift EPS by 8%.

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